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    Life Cycle Income Explained with Human Capital Theory

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    Using the economic theory of Human Capital, describe and explain the theoretical basis for income changes over the life cycle.

    In other words, why it is that earnings increase at a decreasing rate, as one ages (why are returns diminishing - as is observed empirically)?

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    Solution Preview

    It has been observed empirically that earnings often increase with age but at a decreasing rate - and both the increasing and decreasing rates are directly related to the level of skill, Becker (1992) notes. Within human capital theory there are several explicative factors. One is simply diminishing marginal productivity: years of experience increases with age - thus the absolute level of productivity may be higher, however the marginal gains in productivity reduces each time period (i.e. each year). Logically, it follows that the absolute increase in experience ...

    Solution Summary

    This solution is a 300-350 word explanation of how human capital relates to (and predicts) diminishing marginal productivity and income. The explanation provides examples and cites the work of Gary Becker (a Nobel prize winning Economist). In addition to providing a traditional human capital theory explanation, the solution's author uses the principles of human capital to offer an additional explanation of empirical (research-based) observations.